Huhtamäki Oyj (HUH1V), a global leader in sustainable packaging solutions, reported a 14% increase in profit at the adjusted EBIT level for Q2 2024, despite a slight 1% dip in sales. The company attributed this growth to its successful boost savings program and various efficiency initiatives.
Demand in on-the-shelf categories grew, while on-the-go categories softened due to high inflation affecting the hospitality sector. Huhtamäki also made strides in sustainability, surpassing its goals for renewable electricity and waste recycling, although it fell short on the use of renewable or recycled materials.
The company's outlook remains positive, with expectations of continued savings and contributions to sales and profit growth from its Flexible Packaging (NYSE:PKG) segment.
Key Takeaways
- Huhtamäki's Q2 adjusted EBIT profit rose by 14%, with a margin of 10.2%, despite a 1% decrease in sales.
- Savings from the boost program and efficiency initiatives in sourcing, labor, and waste reduction contributed to profit growth.
- Sustainability targets for renewable electricity and recycling were exceeded, but the use of renewable or recycled materials did not meet expectations.
- Foodservice Europe, Asia, Oceania faced soft demand, while North America experienced growth in sales and profitability.
- Flexible Packaging and Fiber Packaging segments showed positive growth, with the latter affected by a fire and avian flu.
- The company's long-term ambitions include a 10% EBIT margin and improved return on investments and equity.
Company Outlook
- Continued accumulation of savings anticipated throughout the year.
- Positive contributions to sales and profit growth expected from the Flexible Packaging segment.
- Long-term ambition to reach a 10% EBIT margin, improve return on investments and equity, and reduce net debt/EBITDA.
- Capital expenditures projected to be lower in 2024 compared to the previous year.
Bearish Highlights
- On-the-go categories softened due to high inflation in the hospitality sector.
- Volume declines influenced by geopolitical tensions in the Middle East and the Red Sea (NYSE:SE) crisis.
- Renewable or recycled material usage fell short of targets due to product mix.
Bullish Highlights
- On-the-shelf categories saw an increase in demand.
- North America reported pricing-related sales growth and improved profitability.
- Fiber Packaging segment experienced solid net sales growth and profitability.
Misses
- A slight decrease in overall sales by 1% compared to the previous period.
- The renewable or recycled material target was not met due to the mix of products.
Q&A Highlights
- CEO Charles Heaulme addressed the non-material impact of a boycott on the Fiber Foodservice segment and the company's continued focus on the profitable core business in the US.
- Investments in the US market, such as in smooth molded fiber, egg packaging, and folding carton categories, remain unaffected by the slowdown in demand.
- CFO Thomas Geust discussed stable to improving gross margin expectations, the impact of a fire and avian flu on Fiber Packaging, and capital allocation priorities.
- Pricing pressure acknowledged, with raw material prices stabilizing and pricing adjustments made for the year.
- Variations in plastic raw material trends between North America and the rest of the world due to different types of plastics and geographic pricing differences.
Full transcript - Huhtamäki Oyj (HOYFF) Q2 2024:
Kristian Tammela: Good morning, all and welcome to Huhtamäki’s investor call for the Second Quarter of 2024. My name is Kristian Tammela, VP of IR. We have this morning released our results. And as again, we will start with presentations by our President and CEO, Charles Heaulme, followed by our CFO, Thomas Geust. And after that, we will go to a Q&A session. Before that, I’d like to remind everyone of the upcoming site visit to our site near Chicago on September 4. If you are interested, please feel free to reach out to the IR team. And with that, let’s get started and handing over to Charles.
Charles Heaulme: Thank you, Kristian. Good morning to all of you and thank you to all for joining us for this release of our second quarter results and first semester. I will start with a quick summary on our results and the business context for the second quarter. And I would say that in one word, I would summarize that Q2 was extremely consistent with Q1, however, slightly better, if I may say it like this, and I will give you a few insights before going into details. The first point is that we are continuing to see some signs of increasing demand with, however, some differences between geographies and categories. We see particularly improvement in on-the-shelf categories, so the food and everyday necessities. And there, we are seeing, like we said at the end of the first quarter, but even more positive, we see volume growth versus the same period of 2023, as mentioned already in the first quarter, but even slightly better in the second quarter. At the same time, we see that the on-the-go categories are softer. We believe that this is a temporary arbitration from consumers as a result of the high inflation that we have seen in the hospitality sector, in the restaurants, in the quick service restaurants, in the coffee shops, and that drives the demand slightly down during the first semester of the year. The market environment in a nutshell is still impacted by the high inflation, which has been particularly high for food products, and as I said, even more for food service products. There are also impacts which we hope will be only temporary in the year 2024. That is coming from the volume decline due to the war between Israel and Hamas, and also the Red Sea crisis has impact on logistics and, therefore, on the international trade. From a financial performance point of view, that drives our sales slightly down, minus 1%. We will see exactly the components of it, volume being very close to last year same period for the second quarter and for the first semester. At the same time, we continue, we actually increase the acceleration of our profit growth. The profit is growing 14% at adjusted EBIT level, and the margin, again, adjusted EBIT margin level is reaching now Q2 10.2%, whereas the first semester was 10%. A major contribution to this profitability increase is actually the savings that we are delivering – continuing to deliver in line with our boost savings program that we introduced in the end of 2023, and I’d like to give first a reminder about this program that we announced late 2023. It’s a program that is targeting to save €100 million between 2024 and ‘26, so in 3 years on tackling costs on 4 areas: sourcing; material efficiency, so in other words, waste reduction in our manufacturing entities; labor productivity; and also footprint optimization, particularly the manufacturing footprint optimization. So after this reminder about the overall program, the right-hand side on the slide that you can see online, where are we at the end of the second quarter 2024. Well, the initiatives are in execution in all areas. That was the case already in Q1, achieving at the end of the first semester, savings which are above the linear trajectory that the €100 million would give over 3 years. So that’s already a very positive sign and that has contributed materially to the profit expansion that I will explain in a couple of minutes. And it has also compensated for the high inflation that we see, particularly on labor costs. So far, program-related costs that we are accounting and Thomas will come back to this in the IAC, that amounts for €15 million during the first semester, and that includes a positive impact from the divestment of our real estate in China. China being, if you remember, one of the manufacturing footprint optimization that we announced during Q1. During Q2, we have actually continued all our activities in sourcing, in labor productivity, in waste reduction, but also we have initiated two other projects for manufacturing footprint optimization – consolidation. One announced on the April 23, which has to do with the consolidation of our foodservice manufacturing in Klang near Kuala Lumpur in Malaysia. And the project completion is done by the end of this second quarter. I have to say that the product in China and the project in Malaysia have been conducted perfectly according to plan and will deliver the savings plan. The second, on May 31, we announced the consolidation of our three factories in UAE into two entities and that will happen during the second semester. So, last point to conclude on this efficiency program that we are expecting to continue accumulating the savings during the 3 years with most likely, as we see it, savings, which are above the trajectory during the first semester, but should remain like this during the year 2024. Going now into some specifics on the second quarter and first semester performance, first, starting with the sales of the second quarter, the sales which decreased 1% and that was very much in line with what I said before, linked to volume and pricing being the two components, but being very close to the previous year’s level. While we still had, when we’re talking about comparable net size growth, we still had a minus 1% from currency impact. Thomas will present further details on this. On the first semester, sales decreased 3%, so you get that the second quarter is actually a better trend in relative terms versus 2023 than Q1. In the first semester, altogether, comparable net sales growth, minus 2% after deducting the currency impact negative minus 1%. And as said, the volumes, I’ll come back again in more details by segment, but the volumes are close to last year with differences between categories and geographies, where we see more impact is on the pricing where the competitive pressure is there. We are holding well, but slightly negative on pricing. Looking at now the same sales, comparable net sales growth, but broken down by segment, we see clearly what I was suggesting in the introduction, meaning the food on the shelf is growing in terms of sales, but also even more in terms of volume, the packaging for food on the go. So basically, foodservice is seeing a temporary decline, which is linked to a demand where all the market intelligence we have is showing that consumers are temporarily reducing their out-of-home consumption linked to the high inflation that this sector has seen altogether. So that means Foodservice Europe, Asia, Oceania sales minus 6% in Q2. Part of it is pricing part. Part of it is also the onetime effect I was mentioning regarding the Gaza war that is driving boycott of the U.S. brands or Western brands, in general, and that’s an impact which is sizable, also the logistics from the Red Sea crisis. North America is minus 2%. North America is purely pricing. The volume is basically flat with actually some good news also in some categories in North America. So the performance is actually quite solid. The good news is on the packaging for food and everyday necessities on the shelf there we see the flexible packaging where we are growing the sales 2%. And actually, the volume is more than the 2%, so we have also pricing pressure in the flexible segment. And then Fiber Packaging is also a nice growth. Let’s remember that in Fiber Packaging, which is, the core is egg packaging, but we have also foodservice products into the fiber packaging, for instance, the cup carriers, which are suffering the lower demand of foodservice. So the, let’s say, underlying growth of the core business in fiber is really positive. I’ll come back to that a bit later. This translates into the P&L for those following with the presentation offline, Slide 8. Looking now at the P&L in the second quarter with those sales which are flat to slightly negative, minus 1%, we are delivering a profit growth of 14%, reaching in Q2, and adjusted EBIT margin of 10.2%. And that means year-to-date 10.0%, so on the first 6 months of the year. And when you compare it to the profitability a year ago, 8.8%, then this is a substantial material improvement, which is linked to all our cost reduction programs that we have initiated already in ‘23 and accelerated in 2024. Good to mention also and that’s valid for the quarter two, like for the year-to-date, that the adjusted EPS is following exactly the same improvement trend as the operational earning, which is good. We have slightly reduced our – well, slightly – maybe I should say, substantially reduced on CapEx, but I’m saying slightly because there is a timing effect into it. So it’s not like we are planning to reduce our CapEx on the full year by 37%, as you see it for the first semester, but still CapEx will be lower. You may ask questions on this. Then sustainability performance continues to progress in line with our targets. I should even say that we are above our linear trajectory to 2030 with our sustainability performance. I may comment a number that is not on this slide, but we have told you that we have introduced a global sustainability and safety index since 3 years now and this Global Sustainability Index when we projected from 2020, the baseline to 2030, our long-term target, starting with an index 100 to an index 200 in terms of target by within 10 years. We are at the end of H1 2024 at an index 158. So this is really a solid performance. We are above the linear trajectory that is linked to basically all the indicators, including safety. But on the specific environmental sustainability, as you see in the slide, we are improving in renewable electricity, for instance. Let’s remember, in 2019, we were at 0%. Last year, we were at 36%. We are at 55%. It doesn’t mean that in 1 year, we will be at 75%. So it’s not a linear progression. They are projects, which justify this acceleration. Other indicator we are very proud of is the recycling of industrial waste. It was 70% a couple of years ago. We are at 81%, or on the bottom of the page, the waste to landfill was, if I remember well, 17% in 2020, we are at 6% now. Last year, it was 9%. So we are progressing consistently period after period, year after year. One indicator is in the red, that’s the one you see on the top left corner of the slide. That’s the renewable or recycled material. You have to see it as indeed a reduction, so which is not according to our target. But that’s purely linked to the mix because of what I explained before. We are growing in flexible packaging in 2024. We are not growing in the foodservice, which is mainly or even thoroughly a paper-based product and, therefore, that has a mix impact. It does not change our long-term ambition. Looking now at some details of the business and performance per business segment, starting with Foodservice Europe, Asia, Oceania, where we’ve seen market softness in Q2, exactly according to Q1. So no change, but no change for the better, actually. So the demand for food service packaging has remained soft, affected by the high inflation on food products, but even more the inflation in quick service restaurants has been even higher. I would like to give maybe a small indication of light out of the tunnel is that we see our customers, the big brands, the foodservice players actually starting promotional activities in the beginning of Q3, which are there – well, it’s for them to comment upon it, but our interpretation is that they want to re-attract consumers and to mitigate, let’s say, the impact from this inflation. Despite this challenge in the top line, in the volume and size, and overall in Foodservice, we are maintaining our margin at 9.2% adjusted EBIT margin, which is a good result in the context and that’s also the result of our savings activities across the company. Moving on to North America. North America sales, as I said before, a comparable net sales growth of minus 2%, very much pricing related. The demand remained basically unchanged versus previous years with some differences by categories. Basically, what we see more and more in the U.S. to push the consumption is a lot of promotional activities by, for instance, retailers, and that is driving price pressure, of course, in the value chain for us, but also potentially better volume projection going forward. The remarkable achievement in North America, which is very much in line with Q1, is the continued improvement of our profitability, but it’s not an incremental improvement. It’s a substantial improvement from 12% to 14% adjusted EBIT margin, so 2 points improvement linked to a favorable cost environment, but also linked to our cost savings program. And then I should have mentioned also on the sales side that we are starting to see traction from our investments. For instance, in the egg packaging in the new Hammond factory in Indiana near Chicago, even though in the first semester, it is still, how should I say, marginal value, therefore, projecting for the next semester or even for 2025, then that’s clearly a vehicle for growth for us. Second, you may remember that we are currently investing and installing a second factory or the expansion – the duplication of our factory in Paris in Texas, in the U.S., in foodservice, and that factory will be ready in January ‘25 with commercial production. That also gives a positive perspective to the sales growth, which will also, of course, support profit growth in North America. Flexible Packaging. We know that this was our segment with the lowest performance until last year. We are seeing good signs of our strategy, of our innovation deployment. Our volume growth is positive in 2024 in the first semester, in the second quarter, also – actually in the second quarter in relative terms, a bit higher than in the first. So also that’s positive. And there is also pricing pressure in flexible packaging. But all in all, we see that our strategy is starting to unfold positively, and that translates also in a slight margin increase from 5% to 6%. Early days. We are far from where we want to be, but that’s good signs of better performance in that segment. Finally, on the Fiber Packaging that I started to suggest at the beginning. There we continue to see solid net sales growth and profitability. I would like to mention that the 3% comparable growth, which is good, could be actually much more positive for the second quarter. And the reason is we have suffered a few – we are still suffering a few impacts, which are temporary in this segment. Number one, you may remember we had a fire on the production line in Australia in January. That line is still not operational. So that’s a temporary impact, but structurally, this will be further growth going forward. Second, in Q1, there was Avian flu in South Africa, apparently resolved by now, but in Q2, started Avian flu in Australia, which is hampering also the growth of the second quarter. But still, we have a solid growth and a solid profitability improvement, which is linked to not only this top line growth, but also linked to the operational improvements that we have made in a number of factories, particularly in the Netherlands. With this, I hand over to Thomas for the financial review.
Thomas Geust: Thank you, Charles. And let’s start with slightly a recap of what Charles just said. I would say that overall, we were hampered by the growth in convenience, however, of course, supported by then the, I would say, improving trend in the on-the-shelf products. So with that in mind, I would ask you to pay attention to the two changed columns. If you are looking at those ones, you will actually conclude that looking at the full year performance to date, H1, we are trending better in Q2 on basically all the parameters, except for on the tax row. So from that perspective, I would say the trend is right. I admit that it is supported by slightly the wrong things, but they are all important. So the cost-out activities are definitely helping us with the profit development, which is, as said, good. It is also tailwinding from the commodities still here. So with that in mind, when we would see the recovery in sales we would have the additional benefit of leveraged growth coming into the P&L. With that said, obviously, we also see some stabilization in the commodities and in some commodities, even uptrending efforts currently going on. On the tax rate, we are roughly on previous year’s level. I think we had 23.5% last year, now roughly 24%, so more or less the same level. And then you see that the hit we got on the interest, on the finance cost in the first quarter, we didn’t get a similar hit in the second quarter. So stabilization also there, which is a good bridge into the next slide where we have the currencies. So you can see that all in all, on average, the currencies are moderating, so moderating from a negative impact point of view for us. We had only, may I say, €6 million on top line in the quarter, while the year-to-date number was €23 million. Especially if you look on the closing rates, you will see that the negative signs start to diminish. So if you compare that to the average rates on the left, many of the currencies are now starting to trend more favorably for us in – or have trended. You never know where the currencies will be going, but have been trending now more favorably for us. Net debt levels and all in all, balance sheet strength, we are basically on the low end of our corridor, so at two when it comes to net debt/EBITDA. So the continued deleveraging has been continuing here, also taking our gearing to a more favorable level. We have a strong cash equivalent position in our balance sheet, which is actually now slightly supporting our finance cost as well, as we get some benefit out of the cash we have on the balance sheet. And then all in all, the absolute net debt level at €1.255 billion, which is significantly down after the acquisition of Elif. Loans and maturities. The majority of our loan structure is today, fixed. We have clearly reduced the amount of commercial papers, especially that part of floating rate-based papers have come out. The loan maturity is roughly on the same level as previous year same period. And as usual, we are continuously looking into various activities around financing and especially when it comes to maturity. On the free cash flow side, here, we have two elements strongly supporting. One, the capital expenditures being lower year-to-date. We actually project the CapEx to be on a lower level compared to previous year. So a lower CapEx level in 2024 versus 2023. I would say, we will be below €300 million. Then when it comes to the other elements here, we have support also from asset sales. Charles already referred to some of the sales in connection to China. We are also, when you compare that to our IACs, one can conclude that with our IACs, which were roughly €22 million on EBIT level, we are on IAC EBIT impact, basically close to half of previous year same period. And most of the IACs are non-cash. So cash contribution from sale of assets in this case. When you look at the financial positions, you see that we are improving on our balance sheet KPIs slowly, but surely, on return on investments and return on equity. You see the working capital being down versus previous year. So our relative performance when it comes to days of working capital is improving. On the other hand, if you carefully analyze the balance sheet, you will realize that our inventory is up versus year-end, and that’s mainly on the finished goods side. So allowing for delivery of products in the second half. And with that one, we come to the long-term ambition. In the long-term ambition, we conclude that we are dragging behind on sales; however, if you look versus the previous charts there, it’s basically on the same levels of minus 2, the same we had in previous year full year. Then if you take the adjusted EBIT, that’s, of course, a good, good level – or good thing to be able to say that we now reached the lower level of our ambition. So we have reached the 10% EBIT margin for the first half of the year. The return on investments, as you see, are continuously improving since basically 2021. And then we have the net debt/EBITDA at the low end of our corridor. And dividend payments were carried out the first part in May this year, and the second part is still to come in the autumn. Outlook and short-term risks, we have done no changes to our statements. So with that one, I would open up for Q&A and maybe also from my side, remind you of the event we would have in Hammond. As Charles said, it’s a factory which is being ramped up, so it’s a good time to see how an industrial scale-up happens in reality.
Operator: [Operator Instructions] The next question comes from Ephrem Ravi from Citigroup. Please go ahead.
Ephrem Ravi: Thank you. Two questions. Firstly, can you give a quantification or color as to how much has been the impact of the boycott of the global brands in certain markets like Middle East has been on the top line? And is it fair to say that the impact started in mid-4Q last year and, hence, it will be first quarter 2025 until the comparison base for the prior year fully reflects that kind of impact? And secondly, does the slowdown in demand, especially in North America, also push out the growth investment programs over there. This is especially in the context of the decrease in CapEx. And would it also be fair to say that the CapEx rates will not pick up until you see the top line growth in the order of magnitude of your long-term ambitions? Or will you accelerate it if you feel there is sufficient visibility on growth? Thank you.
Charles Heaulme: Thank you for your question. I’ll maybe start answering and then Thomas, you can, of course, complement as usual. First of all, the impact of the Gaza war on the boycott of U.S. brands, particularly. I mean it’s impacting basically only one segment, which is the Fiber Foodservice segment, not North America, obviously. And that impact you asked, when did it start? It really started to materialize indeed at the end, I would say, at the end of the fourth quarter last year. I mean the one starting on the 7th of October, it really started, I believe, or it was visible to our customers and to us in the end of the fourth quarter. So you’re right in your assumption. It’s there to stay, we believe. Because once consumers change their consumption habit for a strong belief like this, then there is no reason is going to change back in the short-term. I’m not saying forever, but in the short-term. So from a comparison point of view, Q1 2025 will be the first time where we are not speaking about it anymore. At group level, the impact is not material, but it is small – a very low single-digit impact still on the overall volume of the Foodservice segment. The second question, which has to do – or maybe you want to complement on the first one, Thomas?
Thomas Geust: I think that’s a complete answer, yes.
Charles Heaulme: So on the second question, I understood your question was specifically directed to U.S. and to the slow demand in the U.S., whether it is pushing away on investments and whether that was compromising our long-term growth. I would like to say, not at all. Okay? So on the U.S., U.S., as you’ve seen, is our most profitable market, market and also segment. That’s number one. So therefore, investing when we’re saying in our strategic priorities that the number one priority is to scale our profitable core business, well, that’s one of the directions. We want to scale our business in the U.S. Therefore, we have invested in smooth molded fiber to grow the table where we have a brand, which is our most profitable category. Second, we have invested in this famous Hammond factory, where we are inviting you to visit on the 4th of September. For egg packaging, where we were not present, now we are present and this is a growing market. Third, we’re investing in the folding carton in a demanded foodservice category in the U.S. So there is absolutely no reduction of investments for us in the U.S. On the contrary, we are strong believers of the need to invest there. Our lower investments are more to be seen in other categories like in foodservice or in flexibles, where we want to have proof of the market, but also that our innovation is really being successful in order to further invest. So it’s kind of being slightly prudent for further deployment and, therefore, pushing a little bit further away on some of our investments. It does not – it’s not our investments that are compromising the long-term ambition on growth; however, this year, 2024 is very clearly not in-line with our long-term ambition of growth and that’s market related. It’s not investment related. It is market related because of what we explained the demand is low.
Ephrem Ravi: Thank you.
Operator: The next question comes from Robin Santavirta from Carnegie. Please go ahead.
Robin Santavirta: Yes. Good morning, and hello everyone. First question I have is related to the volume outlook in Q2. Apparently, your underlying volumes were flat year-on-year. What is the outlook for H2? Should we expect a small increase in the volumes with the information you have today?
Charles Heaulme: Okay, thanks. Good morning, Robin. Thanks for the question. So first of all, before talking about volume outlook, I’d like to remind that on H1, if you compare to where we’re coming from in Q3, Q4 2023, we have seen market conditions slightly improving. Are the market conditions improving according to our expectation and our plan? Absolutely not. Okay? So this is very clearly the recovery of the consumption is much slower than we were expecting or hoping. That’s number one. However, the numbers in Q1 are showing signs of better demand, and Q2 even more, but it is slightly. What do we see in H2? We see that – so the recovery of the consumption for us is not a question of if, it’s more a question of when. And we had hoped and I should say, bet that it would be in 2024. It may be 2025, but it may be also starting in the second semester. In some markets, take the U.S., for instance, it’s very clear, consumption depends, of course, on inflation, but depends as much on the interest rate because consumers use a lot the credit facilities. And when there is high interest rate, it is reducing the consumption. So as soon as the interest rates will go down from the central banks, then we are expecting to see consumption growing progressively, growing again. Second, let’s remember always that we are ramping up with a number, and Thomas mentioned it, we are ramping up in a number of additional capacity that we have put in place in foodservice in Nules, in Spain; in our lead production in Alf in Germany, and we have further investments ongoing in the UK where our customers have clearly asked us to invest in order to supply their demand. In egg packaging, in North America. In smooth molded fiber in North America again. In folding carton in North America, again, so profitable growth. So we have mechanical impacts that are going to come and that will sustain a better performance, so therefore, I would not say to you today that we are bullish about the outlook H2, but we are reasonably optimistic. Thomas, would you like to complement?
Thomas Geust: Yes, and highlight that. Exactly as you said, we are pretty confident around the committed customer contracts that we have got, the new products, which will be available from Hammond and so on. So that’s, in a way, bringing growth. The biggest uncertainty is, obviously, the recovery in the foodservice market. How quick is it and which sort of customer segments will be the winning segments. So that’s the question mark for second half, but all in all, growth.
Charles Heaulme: Actually, the foodservice, when you look at our results overall, and I hope I was clear in presenting. When you look at our results overall, there is a tree hiding the forest, if I may say it. So the foodservice temporary hiccup is hiding the growth that we have in other segments, and we should not forget that. So, the question – the concern we have today, the main one is how long will it take for consumers to return to their normal convenience habit, to dine out unless at home and therefore, sustain the growth, the long-term growth of the Foodservice segment. That’s the key question.
Thomas Geust: The lower-end brands have been gaining traction in the market, which is an evidence of people looking for cheaper products.
Robin Santavirta: I understand. Thank you very much. The second question I have is related to the gross margin. Gross margin seems to be on a quite elevated good level for you guys. How much of the gross margin improvement comes from the cost cutting or rationalization measures, the €100 million program. And then related to gross margin going forward, if we disregard input costs and only think about volume and continued rationalization measures, should we expect, if we disregard input cost that the gross margin could even go up from these levels? I understand input costs can change to set, but that we understand, but what you know better than us is the company’s specific measures and the potential leverage from volume on gross margins, so if you could sort of comment and give a bit more detail on that.
Thomas Geust: Yes. So, my first comment would be that we basically see no leverage from growth, obviously, in the first half. So, from that perspective, it’s a mix – partly a mix thing, but majorly the cost out that you referred to. When you talk about gross margin, I would highlight the first fact that one of the bigger contributions we have is actually on value-add level. But the value-add level is not completely a market-driven value-add improvement. So, in the value-add improvement, I would say, a big part of that one comes from the activities we have had around the sourcing on that level. So, to conclude the majority of the gross margin improvement comes from cost out activities, we have more than offset, I would say, the headwinds we have had from volume and from low-ish volumes and from labor cost increases.
Charles Heaulme: Yes. I think it’s really important what you highlighted, Thomas. At the end it’s, when we are talking about input costs, we should not forget that, yes, the cost environment is positive right now with raw materials, for instance, but we have a major inflation on labor. This is a big impact. And that is neutralizing some of the effect from this favorable cost environment.
Thomas Geust: And hampering the gross margin, so explaining partly why value-add is improving more than gross margin.
Robin Santavirta: And in an environment where input costs would remain stable, I know there is some pressure and some cost, but in an environment where they would remain stable, if we get volumes, will the gross margin remain at least at this level or even improve?
Thomas Geust: Yes. I mean leverage – from the leverage point of view, you can basically assume we have a slight negative impact from the depreciation coming on stream, so you would get benefits from that one when you see volumes. And therefore – and we don’t believe we need to add that much production overhead in order to carry growth. So, with other words, you should assume that the part we need to slightly add is labor. So, we will get close to contribution margin type of profits delivered to gross margin. Environmental [ph] part, just to be clear, not from everything.
Robin Santavirta: Thank you very much.
Operator: The next question comes from Pallav Mittal from Barclays (LON:BARC). Please go ahead.
Pallav Mittal: Yes. On behalf of Gaurav Jain, I have two questions. Firstly, on the Fiber Packaging segment, you highlighted the impact from a fire in a line in Australia and the impact from flu in Africa. Can you please quantify that impact on the Fiber Packaging segment? And secondly, now leverage is 2x, which is towards the bottom end of your 2x to 3x ambition. So, when we think about capital allocation, will it be directed more towards bolt-on M&A, or should we also think about some share repurchases?
Thomas Geust: So, I didn’t quite get your other questions. Could you repeat that?
Charles Heaulme: It was difficult to hear it.
Thomas Geust: Could you repeat that one? So, what will we allocate the money to?
Charles Heaulme: So, let’s see if I – you will tell us if I understood correctly your question, the second one is that our leverage is much better. And your question is about our capital allocation, are we going to use it for bolt-on acquisitions or for share repurchase? That’s what I understood.
Pallav Mittal: Yes, that’s correct. Yes.
Charles Heaulme: The first one was about the impact on fiber from the fire and the flu, the Avian Flu. The impact basically is that we would have had a positive growth in – so we have very good positive growth. When you see the sales growth of 3% in fiber, it was basically twice as much in Europe and basically flat in the rest of the world. So, you can get an understanding that the impact, of course, of those cumulated three events. So, one line out of – we have lines – when we say rest of the world, we have lines in Brazil. We have lines in South Africa. We have lines in Australia. That has a fairly significant impact in our growth, this fire. And the flu is a severe impact, it was in South Africa. I think in Q1, 30% of the sales were affected because basically the bird population has been taken away. In Australia, my understanding is that it’s a bit less of a magnitude, but the problem is that it continues. So, it was just kind of at the beginning, starting as a small event, limited event. It looks like it carries on, so difficult to say at this point if it will have an impact also in Q3. But that’s a sizable impact.
Thomas Geust: I can take the other one. So, first of all, I would say, in the current continued relatively unpredicted environment, so with a lot of things going on everywhere, I would say we are more than happy to be more on the lower end of the leverage and I could even be okay with going below the corridor of two. So, that’s my first statement. Then when it comes to priority of capital, that still remains. So, with other words, the two to three corridor is a relevant corridor in any case. And when it comes to the priorities, I would say, first priority CapEx, second priority M&A and share repurchases. We don’t have up for consideration for sure, not at this time. When it comes to M&A, CapEx was already discussed, so there we are careful about timing. We are not foreseeing that we will become a significantly lower CapEx company, but it’s more about the timing on an average, let’s say, mid, short-term basis. But then on M&A, the priorities currently, I would say, is, due to these market uncertainties, to look in that case for companies in places which have stability.
Charles Heaulme: Indeed. And also for the right valuation, so it’s not like – because we don’t announce anything, we are inactive, but we are looking for the right valuations. And there isn’t always coherence between the buyer and the seller in terms of valuation, but we are not inactive.
Pallav Mittal: Thank you.
Operator: The next question comes from Calle Loikkanen from Danske Bank. Please go ahead.
Calle Loikkanen: Good morning. Good morning gentlemen and thank you for taking my questions. A couple of questions regarding the margin, if we look at the adjusted EBIT margin, it has improved year-over-year for the past four quarters 1 to 2 percentage points, so quite sizable improvement. Now, looking at H2, do you think you can continue to improve the margins at that kind of rate, or will the change in margin be smaller or even flat in H2?
Charles Heaulme: I think so again, Thomas, you may complement after, but good morning Calle. So, in H2, absolutely, our aim is to maintain our 10% EBIT margin. I think we have and particularly Thomas in his previous comments mentioned that if we are relatively optimistic about the volume development during H2 and going forward, that will support a further improvement of the profitability. So – plus, we foresee a continued delivery of our savings program, which is front-loaded as we see. We have good savings in 2024, and those savings are structural, so they are not temporary. And therefore, we are relatively confident to continue in that trajectory.
Thomas Geust: Yes, I will complement on that one. First of all, I would say the first question should be, will we continue to deliver profitable growth, and with profitable growth, I would always refer to growing in absolute terms the profit. The indications we had here earlier was that we believe on the shelf is the one, which has more traction. Obviously, one element, which will slightly have an impact then on margins is – although we believe also flexibles to improve, but we will have the mixed picture of one segment with a lower margin profile, hopefully growing quicker than some of the other segments. So, that element, I would say the mix element as such might have an impact on the relative margin, but still we are more than happy to see a contribution to the absolute margin.
Calle Loikkanen: Yes. Thank you. That’s very helpful and good point with the sales mix as well. And then perhaps secondly, on North America margins, the margin targets you have for this segment is 11% to 12%, but North America has been growing kind of further and further above that range. So, what should we expect from the margins in North America going forward, should the margins be coming down, or would you need to hike the target for this segment?
Charles Heaulme: Thank you, Calle. This question is coming back consistently. And we don’t mind further improving beyond our target. It’s always better to under-promise and over-deliver. So, we are not planning to change our target short-term for the long-term. But obviously, now that we have reached the EBIT margin of 14%, then we want to stay in that area with some fluctuation depending on the cost environment also, of course, but I would like to go back to what Thomas was saying, we are not managing the company just for the margin. Our number one priority is profitable growth, okay. So, if we can accelerate the growth with a category that would be only 11%, and therefore, as a mix impact, it’s negative on the profitability, then we would do it, okay, because that’s good for the value to shareholders. But of course, we are – the more we will scale, for instance, in North America, the better it will be to maintain 14% or 13% to 15%, let’s say, that would be on the long run, what I would say. That’s why we want to scale that segment.
Calle Loikkanen: Alright. Thank you. That’s helpful and that’s all for me. Thank you.
Operator: The next question comes from Maria Wikstrom from SEB. Please go ahead.
Maria Wikstrom: Yes. Thank you. This is Maria Wikstrom from SEB. I still have a few questions. Firstly, I would like to touch about the Indian market, which represents a quite large share of your sales. If you could describe currently what is happening in the consumer demand in India specifically?
Charles Heaulme: Good morning Maria. Yes, India, so we are seeing a relatively positive development of the market, at least favorable to us. We have a good growth. Our net sales are growing 3%, but with some pricing pressure, meaning that we have a higher-single digit growth in terms of volume. The domestic market is improving. You may remember that in India, basically half of our size is domestic sales, half of our size is exports to other markets, Middle East and Africa, particularly, U.S. also. And this is on the export business that we are suffering more because of the Red Sea crisis and because of the overall inflationary environment, which has driven the expense to be lower. And the export business is structurally of slightly higher margin. So, from a mix point of view, that’s not favorable. But again, it’s not something that is structurally a problem. We are happy – actually, what would be more structural problem is if we will not grow in the market and we grow in the domestic market. So, the exports will come back and that will be really positive for India.
Maria Wikstrom: Perfect. Thank you. And then I would like to hear your comments about like the current price pressure from lower raw materials. So, if you would describe that like how do you expect the pricing pressure in the second half of the year compared to the first half of the year?
Charles Heaulme: So, the price pressure has been higher in H1. You can read through profitability that we have been actually when you compare to overall the market, we have been resilient in our pricing strategy. What do we expect for the coming months, first of all, the raw materials are not decreasing – the prices of raw materials are not decreasing anymore. They are stabilizing. And in some categories, they have started to increase. So, it’s almost impossible to give a one-size fits all answer to this question, because if I take recycled fiber, for instance, the prices have increased not dramatically, but very substantially in Q2. We have immediately of course, activated – with the agility that we have gained over the last years, we have activated price increases. The feedstock is overall lower this year, but we see now resins and polymers increasing again. Not increasing to the level where they were in 2022, but increasing. Therefore, the cost environment is not going to further, or should I say, sustain a pricing pressure. But let’s put it like this, the pricing impact that we have seen in H1 will be there in our P&L in H2, okay, as a relative comparison. But the pressure from the market is not going to increase further because labor inflation is increasing – is further increasing so that’s also something that comes into the picture. And then the last point extremely important is why is there pricing pressure, because there is low demand. And therefore, there is basically overcapacity across the categories and geographies. Once the demand restart then the pricing pressure will ease. So, this is not a simple equation, but it’s the trends that we will see going forward.
Thomas Geust: I would say the pricing adjustments done so far were very natural in the sense also that we adjusted for the annual contracts in a way. So, those changes were done, and we don’t expect that to happen again this year, when you start again negotiations for next year, that’s a different story. But the other element, I would say that as a counterargument, we are for sure not out of the woods when it comes to our second biggest cost item, which is personnel cost. So, from that perspective, one has to look at the overall cost environment when pricing is being done.
Maria Wikstrom: Thank you. And then I had one more, which is, I mean very detailed question, but just curious that you are right in the report that you see plastic raw materials, I mean still, I guess up in North America versus you see them down in the Flexible segment. So, why the geographical trends in plastic raw materials are so different in the U.S. compared to the rest of the world?
Thomas Geust: So, first of all, when you look at that one, we have different type of plastics that you need to remember in various places. In flexibles, a lot of the things we are buying is also films, which is in a way not a pure commodity as such. So, I would say that’s the core explanation for the deviation. And then as we have so many times earlier said also, there is a geographic difference when it comes to the pricing of even polymers despite them being perceived as a global trade.
Kristian Tammela: Thank you for attending the call. This is all the time we have for today. But if you have any other questions, please feel free to reach out to us. With that, we would like to thank you for participating.
Charles Heaulme: Thank you.
Thomas Geust: Thank you.
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